It’s startling to read a large tenant’s lease and discover how less favorable it is compared to what smaller tenants with less leverage achieved at the same time in the market. Sometimes, the rent and other cost exposures are higher; other times, the work letter was poorly negotiated or the company is overexposed to liability. Typically, the reason for this unexpected dynamic is the company’s internal real estate process, which is often fragmented and precise but not accurate.
Building out new office space can be somewhat akin to buying a new car. We have all walked into a car dealership with a firm budget in mind but then we make the mistake of test driving the upgraded model with all the cool features. Individually, the cost of these upgrades seem fairly innocuous; however, when we sit down with the salesperson to see the final tally, we often end up in a completely different price range than we had intended.
Tenants spend a lot of time trying to find the right location for their business. They visit numerous buildings; test fit the spaces for efficiency and suitability and go back and forth on negotiations with the landlord over the economic terms. However, the tenant often fails to realize that after the lease is signed, a lot of financial risk still remains in the transaction. That’s because, in many cases, the tenant still has to build out its space, which can require significant capital and exposure to liability. Thus, if the tenant does not properly structure the construction arrangement for its improvements, its lease deal can end up costing a lot more than anyone expected.
A tenant came to us recently asking for help. They were involved in a transaction with another broker and were concerned about the objectivity of the advice they were getting. The tenant was looking for about 50,000sf of space and was considering a building that was a bit off the beaten track but in an otherwise desirable submarket. They had been back and forth with the landlord (who we will refer to as “Landlord A”) on proposals, and their broker was now recommending to them that they accept Landlord A’s latest proposal as it was “market” or even a little better. In support of his recommendation, and at the request of the tenant, the broker provided information on a number of “similar” deals (market comparables or “comps”) that had recently been done in the “market”. The tenant asked us to assess whether in fact the proposed deal was a good deal.
Let’s just make believe for a moment that landlords don’t pay other entities (both in-house and third party) more when a tenant representative is not involved. Let’s further assume, for the sake of this analysis, that the tenant representative isn’t able to negotiate any monetary savings (let alone several multiples of the commission, as is typically the case). The single biggest driving force for any commercial real estate investor is maximizing return; therefore, consider two scenarios from the landlord’s perspective:
Something happens to us when we are offered something for free: our brains shut down. Free is irresistibly seductive. It is a source of irrational excitement. Witness people who grab coupons offering a free trinket that they have no need for. And people who return to the buffet line for more “free” food even though they are full (and are likely to feel a pang of guilt the following morning).
The site selection process has become far more technical than in the past, and this creates new challenges for companies trying to navigate the globe. As a result, finding the optimal location has become extremely challenging for companies expanding their headquarters, manufacturing plants, shared service centers, call centers, distribution centers, data centers and retail sites.
Your lease has been signed, you have a Tenant Improvement Allowance from the landlord and the landlord is building out your new space. Nothing left to worry about right? Well, maybe there is. Before you turn over your construction project to your landlord, there are several things you should address in your lease to ensure you get the most for your money.